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Repealing the Debt Sentence for Puerto Rico

On top of post-hurricane destruction, outstanding debt and poor climate resilience leaves Puerto Rico in danger of spiraling deeper into economic stagnation. While talks to restructure the island's debt repayment are underway, Poorvi Goel argues that a workable solution for Puerto Rico requires a commitment to sustainable economic growth with climate resilience placed front-and-center.

Ten years of economic contraction in Puerto Rico (PR) have left the island in a difficult position to achieve its sustainable development objectives over the next fifteen years. As PR negotiates the terms of repayment of its accumulated debt, currently proposed restructuring arrangements are unlikely to lead to an economic recovery in the foreseeable future and potentially risk another lost decade of economic growth. Current social, environmental and political factors also run counter to future growth and development as PR reels from recent devastating hurricanes, persistent emigration and a search for national identity in light of their relationship with the United States (US). The decade long recession with the accompanying socio-political undercurrents and environmental events have undermined recovery efforts in PR, and the impending servicing of its debt will be an added challenge to the island’s sustainable development.

Puerto Rico – an overview

Since 2007, average economic growth in PR has been negative, and in early 2017, the Government had accumulated nearly $74 billion in debt, almost 102 per cent of its Gross National Product (GNP)[1] (Figure 1). Preliminary forecasts for growth up to 2022 also indicate negative growth. The length and depth of this downturn indicate an economic depression rather than a cycle of contraction, in sharp contrast to the golden period of 1947 – 1973 when growth averaged 6 per cent per year.

Figure 1: Economic growth of Puerto Rico vs United States; Gross public debt, US$ billion and as share of GNP, 2007 to 2017

The lost decade has also produced an unemployment crisis on the island. In 2016, the labor force participation rate was 42.5 per cent and unemployment rate was 11.8 per cent, compared to about 5 per cent in the US. The GDP per capita for PR is about $28,704 – nearly half that of the US; and the island has a poverty rate of 45% compared to 14.3% in the US. Income inequality is also high in PR, at 0.547 in terms of Gini coefficient, higher than that of the District of Columbia which has the highest income inequality among States of the Union at 0.532.

Compounding the economic woes, PR was hit by a Category 4 hurricane with 150 mph winds, Hurricane Maria in September 2017 following Hurricane Irma, which devastated the water, food and power supply lines and crippled its infrastructure. Even before the hurricane, PR was threatened by sea-level rise and prone to extreme temperatures and droughts, floods, storms and epidemics due to natural disasters. The frequent natural disasters are shaping not only economic activity, but also, the composition of society in PR. Boustan et al. (2017) estimate that a natural disaster lowers net migration into a given American county by 2.3 to 5.9 percentage points, and PR has already been confronting a severe emigration crisis, illustrated in Figure 2.

Figure 2: Population of PR in millions, 2000 to 2016; Migration between PR and US Mainland, 2005 to 2015

Puerto Ricans have a strong sense of identity but with historically conflicting desires for an independent nation-state. Residents of PR are United States citizens but it remains a territory rather than a state, with some authority over internal affairs but not the sovereignty that a State of the Union (SOTU) has. Their 100-year-old relationship with the US has shaped their culture and identity but the Commonwealth status allows them to maintain a distinct identity. However, the economically and socially fraught conditions on the island described above are challenging their sense of identity. In a June 2017 plebiscite, 97.2 per cent of voters chose statehood when presented with three options on the ballot: independence, statehood or status quo. Turnout for the plebiscite, however, was 23 per cent of eligible voters, and statehood remains very unlikely for the island. In theory, statehood would put PR on an equal footing as the rest of the 50 states, and there is a belief that it would empower the island, by allowing equal political treatment to its residents as the rest of mainland US.

The challenge of debt-servicing

Puerto Rico’s $74 billion debt burden[2] limits the island’s ability to meet its other development goals, especially its ability to rebuild after being destroyed by Hurricane Maria. Therefore, addressing its debt-servicing will be a major step toward resolving the challenges of sustainable development for PR, given the complex interlinkages that the debt burden has to other aspects of the economy, society and politics.

Consistent decline of the Puerto Rican economy has led to persistent budget deficits financed by government borrowing. Puerto Rican government bonds were attractive to investors because of their triple tax-exempt status and the guarantee that the constitution provides of payment of general obligation debt before other expenses. However, as the downward spiral of the economy continued over the last decade and less revenue accrued to the treasury, solvency was compromised and risk assessments became increasingly negative. Consequently, the current cash-flow crisis stemmed from a vicious cycle of increased borrowing and incremental defaults.

A number of measures had been proposed ranging from complete debt forgiveness to unforgiving and unaffordable payout plans to creditors, with their own range of challenges – from creating a moral hazard through bailout packages to destroying the already crippled economy, respectively. In June 2016, the Puerto Rico Oversight, Management and Stability Act (PROMESA) established a federal oversight board and launched a process for restructuring debt. However, the fiscal plan proposes spending cuts of $25.7 billion (2.4 per cent of GDP) and revenue increases of $13.9 billion (1.3 per cent of GDP) which would have plunged PR into an even deeper recession. In light of the devastation caused by Hurricane Maria in September 2017, a revision of the proposed fiscal plan is necessary as PR diverts its limited resources to disaster relief efforts. The revised strategy would need to incorporate a commitment towards rebuilding the medium to long-term capacity of the economy, combined with benign debt-restructuring and post-disaster reconstruction efforts for sustainable development.

A potential solution lies in lessons learnt from the London Agreement of 1953 on German External Debts[3] as a successful example of restoring a country’s debt sustainability. Payments were conditioned to certain terms: Germany generating a trade surplus, limiting payments to 3 percent of export earnings due after Germany’s reunification which did not occur until after 1990. Similar terms of repayment could be constructed for PR in its debt restructuring, with payments conditioned to the economy generating a trade surplus, for example, by promoting domestic manufactured goods and service products like tourism. Furthermore, payments can be postponed for a period of 10 years, until after the island has regained its lost decade and sustainably rebuilt vital infrastructure with the help of a recovery aid package from the US, providing jobs to the local population. Imposing conditions on the aid package to redirect aid towards building climate resilient infrastructure will help to mitigate future economic volatility in the case that PR faces natural disasters again. It will also rebuild its long-term capacity, and hence ability to repay the debt. Resilient infrastructure takes into account climatic events to decide the location, design and operation of physical assets as an essential component of climate adaptation, and such reliable, adequate infrastructure subsequently underpins growth and development. Examples include building road surfaces from materials that withstand hotter temperatures and intense rainfalls, and building higher bridges than current practice to accommodate larger tidal waves due to sea-level rise.

It is important to contextualize the environment in which Germany’s debt was restructured and understand its differences with the Puerto Rican situation. Germany was recovering from World War II, had decimated infrastructure and a crippled economy -- much like post-disaster PR -- with debt amounting to approximately 200 per cent of GDP. Within 10 years, it was able to reduce that debt ratio to 20 per cent of GDP, with 60 per cent of foreign debt cancelled by the Agreement and internal debts restructured. Germany in 1953 was an important geopolitical player, and it was in the West’s interests to ensure Europe’s continued economic growth and political stability as a counter to the Soviet Union, as demonstrated by the Marshall Plan[4]. Puerto Rico, by contrast, is a small island, which makes up just 0.56 per cent of US GDP[5], and is effectively treated as an American colony by Capitol Hill.

There are also a number of risks and barriers to tying aid to resilient infrastructure building. Firstly, information gaps prevent translating climate research to implementation. Available research needs to be assessed through the lens of the local situation and context-specific risks and responses have to be examined. Secondly, a range of uncertainties regarding future climate change will have to be anticipated and incorporated into decision models, which may not be well understood. Furthermore, even if aid is tied to infrastructure projects, without a sustainable investment plan, it could be insufficient to match the resilient infrastructure requirements of PR. There is an urgent need for the US to recognize the financial and environmental difficulties of PR and invest time and resources in assessing the complexity of the island’s situation. By looking beyond self-serving economic interests and tying payments to Puerto Rico’s sustainable growth, favorable debt restructuring terms and aid for resilient infrastructure will promote rebuilding of the island; but for this solution to work, political will and a commitment to the island’s long term sustainable development is necessary.

Conclusion

PR is in the throes of a debilitating fiscal, social and humanitarian crisis with a decade-long recession, staggering debt, displaced local population and breakdown of public services following the hurricanes. However, there is an opportunity for the US to redefine its ongoing colonial relationship with the island, reform PR’s collapsed economic model and help lift the island on to a path of sustainable development, in partnership with the local government and community. Without some measure of debt relief and lenient repayment terms, debt growth will continue to outstrip economic growth and without reliable and adequate infrastructure, the local economy will remain volatile. Recognizing these challenges is the first step; identifying means of implementing solutions is the next. The current debt repayment plan can only exacerbate economic and social conditions as more people leave the island to avoid paying debts they cannot afford. Bringing external resources in the form of aid and tying these to PR’s development outcomes will trigger the economy and jobs, and provide an opportunity to Puerto Ricans to rebuild their home. What is required most is political will, and a commitment to rebuilding the long-term capacity of the island.

[1] Gross National Product as opposed to Gross Domestic Product (GDP) is typically more representative of PR’s economy, because it includes income accruing to island residents but excludes the significant portion of income generated that accrues to non-island residents.

[3] The London Agreement of 1953 on German External Debts, or otherwise known as the London Debt Agreement, was a debt relief treaty signed between West Germany (then Federal Republic of Germany) and its creditor nations including the United Kingdom, France and the United States who jointly constituted the Tripartite Commission on German Debt (TCGD). The Agreement was signed in London on February 27, 1953 and came into force on September 16, 1953 (Government of UK, 1959).

[4] The Marshall Plan, named after then Secretary of State, George C. Marshall, was a 1948 American initiative to aid and help build Western European economies after World War II, with US assistance amounting to over $12 billion (US Department of State, 2017).

Poorvi Goel is a student of Master of Public Administration and Development Practice at Columbia University. She has worked as an economist for five years in international development and public affairs, with central government ministries and international organisations in India and UK. Poorvi has authored publications on topics spanning multilateral trade, global value chains, Sustainable Development Goals, Brexit and other emerging issues in international economics. She holds an MSc in Economics from London School of Economics, and a BA (Hons) in Economics from St. Stephen's College, Delhi.